The never-ending story
(Archived)

Since the global financial crisis, forces of change have buffeted the defences of the European Union (EU), threatening to damage it forever. What does the 2016 chapter of the story have in store?

Following the downturn in 2008, apparent inequalities in the recoveries of European economies have arguably presented the greatest danger to the survival of the EU.

Core Europe is deemed to have improved faster, with Germany reasserting itself as the powerhouse of the region, while peripheral nations have in some cases struggled to implement structural reforms without alienating their populations.

The result, says Rowena Macfarlane, sovereign analyst at BNY Mellon boutique, Standish1, has been a surge in more radical and fragmented politics. “There has been a rise of the far right in a number of countries – such as France – and a rise of the far left in Greece, Portugal and Spain.”

Nationalism, cynicism and even a degree of anarchism have all played a role.

Breaking the mould

Macfarlane continues: “Academic research empirically shows the relationship between recessions or depressions and the fragmentation of politics. The reason established politics has seemed increasingly on the back foot is because polling methods have not kept up with the change of mood within these societies.”

In 2015 there were elections in Portugal, Poland, Turkey, Spain and the UK. In 2016 it is the turn of Ireland’s and Austria’s electorates, while there is also a chance the UK referendum on EU membership could be called before the end of the year.

Macfarlane says France and Germany (two of the founder nations of the EU) would prefer for the UK to hold the referendum before the end of 2016. “France has its presidential elections and Germany its parliamentary elections in the spring of 2017, so their governments will not want the press furore around a potential Brexit to impinge on their campaigns.”

Separatist Spain

The pro-independence parties in Catalonia, Spain, spearheaded another separatist movement which was making the headlines in the final quarter of 2015. After a regional election that saw the two main pro-independence parties clinch 47.7% of the vote and 72 of 135 seats, the leader of ‘Junts pel Si’ (Together for yes) said he had a mandate to call a yes/no referendum on Catalan independence.2

However, Mark Bogar, portfolio manager at The Boston Company Asset Management, a BNY Mellon company, says the movement may not have as much traction as it claims. “To a Catalonian business owner the idea of splitting off from Spain could sound interesting – it is a wealthy region and many feel the rest of the country should not be subsidised by its tax contributions. But the reality would likely be a lot more difficult than these politicians paint, and I think once people are faced with the economic consequences they will balk at the idea – much like they did in the Scottish referendum.”

Bogar thinks the fears of Grexit which plagued the summer of 2015 were also overblown. “Greece was always unlikely to leave the eurozone. If Greece had to go it alone with its current level of debt to GDP there would have to be a massive adjustment period, particularly since it would be back to its own currency, which would immediately devalue.”

Stepping down from the cliff

Rather than go for the ‘cliff dive’ of pulling out of the EU, he thinks the path Greece has taken gives it time to adjust more gradually and to find an argument to present to its creditors to lessen the debt repayments over time. Then potentially it can get the fiscal situation under control.

That does not mean the spectres of a Grexit or Catalan secession are gone for good in the year ahead.

Macfarlane says: “We expect the Catalan separatist issue in Spain to continue to make the headlines and Grexit will also likely to come back on the table again in 2016. This is because the bailout conditions the Greek government eventually agreed on require more austerity and spending cuts, which will prove unpopular when implemented.”

Despite this overhang, Macfarlane is not overly concerned about the impact the respective situations could have on bond markets. “Volatility in the lead up to the Catalan regional election was in-line with the political risks presented and underperformance of Spanish bonds relative to Italian bonds was eliminated post the election result.”

Diverging fortunes

She says another welcome development over the past year was a lower degree of spill-over into other markets during periods of localised uncertainty. This is a trend she expects to continue now the PIIGS (Portugal, Ireland, Italy, Greece and Spain) no longer seem to be treated as a collective.

“Europe as a global source of instability is no longer front and centre,” adds Macfarlane, with growth concerns in China having taken its place and most eyes on the US Federal Reserve.

Bogar agrees: “A lot of the structural reform has been done – Spain tackled its banking system a couple of years ago and has consolidated its ‘cajas’ (regional banks). This set the stage for a Spanish recovery and retail sales figures and an improving consumer sector have reinforced this. Italy has also started down this path and we are beginning to see mergers between its ‘Popolari’ (local) banks too.”

Non-performing loans (NPLs) have historically been a problem in the Italian banking sector but now a change in the law has made it easier for the banks to recover them, he says. This should feed through into an earnings recovery in the sector and Bogar believes this potential is yet to be reflected in the share prices of these banks.

He also likes media firms because he thinks advertising spend will increase as companies seek to access the trend of improving consumer confidence in European markets.

Bogar concludes: “We will continue to get newsflow on people wanting independence but I think when the crunch comes the electorate will stick with the devil they know.”

What to watch

The date called for the UK referendum on membership of the European Union – if it is too close to other European states’ general elections trouble could be afoot.

Defaults or pushback from Greece on the terms agreed for its third bailout could see the Grexit debate resurrected.

Further signs of consolidation between regional banks could demonstrate the progress of the reform agenda in peripheral countries.

1.BNY Mellon Investment Management EMEA Limited is the distributor of the capabilities of its investment managers in Europe, Middle East, Africa and Latin America. Investment managers are appointed by BNY Mellon Investment Management EMEA Limited or affiliated fund operating companies to undertake portfolio management services in respect of the products and services provided by BNY Mellon Investment Management EMEA Limited or the fund operating companies. These products and services are governed by bilateral contracts entered into by BNY Mellon Investment Management EMEA Limited and its clients or by the Prospectus and associated documents related to the funds.

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The Boston Company Asset Management, LLC (The Boston Company), is a global investment management firm providing a broad range of active, fundamental research driven equity strategies, including both traditional long-only portfolios and alternative investments.

Headquartered in Boston, Massachusetts, Standish Mellon Asset Management Company LLC (Standish) is a specialist investment manager dedicated exclusively to active fixed income and credit solutions, with a strong emphasis on fundamental credit research.